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A Theory of Debt Maturity and Innovation

Author

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  • Yuliyan Mitkov

    (University of Bonn)

Abstract

I propose a theory of debt maturity as an incentive device to motivate innovation when contracts are fundamentally incomplete and shaped by ex-post renegotiation. The financing of innovative firms must balance two goals. On the one hand, since innovation is inherently risky, the entrepreneur must receive adequate protection after failure. Simultaneously, the firm must be liquidated when its assets can be redeployed more efficiently elsewhere. Meeting these two goals can be especially challenging when contracts are incomplete. I show how an appropriate choice of debt maturity, together with ex-post contract renegotiation, embeds a "put option" into the firm's capital structure. The put is exercised when liquidation is efficient, and it partially insures the entrepreneur against failure and thus motivates innovation. The theory has novel empirical implications for the financing patterns of innovative firms.

Suggested Citation

  • Yuliyan Mitkov, 2020. "A Theory of Debt Maturity and Innovation," ECONtribute Discussion Papers Series 050, University of Bonn and University of Cologne, Germany.
    • Handle: RePEc:ajk:ajkdps:050
    as

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    File URL: https://www.econtribute.de/RePEc/ajk/ajkdps/ECONtribute_050_2020.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Innovation; Debt maturity; Incomplete contracts; Renegotiation;
    All these keywords.

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D

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